The following is an extract of the narration from the BBC television documentary entitled: Inside the Enron Scandal.
"Skilling's bonus was in doubt. His solution was to come up with some very creative accounting. In 1991 Enron did a deal to supply this power station in New York state with gas for twenty years. The first years profits alone would not have been enough to boost Enron's overall position. So instead they declared all 20 year's estimated profits right away. With a few strokes of the pen Enrons profits went up instead of down like magic."
It is submitted that Ernst and Young invoked a very similar effect in their October 1996 report "Independent review of Proposed Merger of Kiwi Co-operative Dairies Limited and Tui Milk Products Ltd".
In their Executive Summary Ernst and Young have the following paragraph.
"For the Tui shareholders they access an additional revenue stream with a present value of 141 cents per kg milksolids for the period of 1996 to 2015. When the retention is considered the net present value gain is 89.83 (141.39 - 51.56) cents per kg milksolids. By contrast Kiwi shareholders, by agreeing to the merger gain access to an additional revenue stream of 33.7 cents per kg milksolids."
This paraphrases the following two paragraphs in the body of their report.
11.2 The realisation of benefits to suppliers will be most evident beyond 2000. In the most likely scenario Tui shareholders will receive 141 cents per kg milksolids (present value) and Kiwi shareholders will receive 34 cents each per kg milksolids in addition to their standalone situation.
11.6 For the Tui shareholder, they access an additional revenue stream of 141.39 cents per kg milkso1ids for the period of 1996 to 2015. When the retention is considered the net gain is 89.83 (141.39 - 51.56) cents per kg milksolids This represents an average yearly increase of 16% on their average standalone return between 1996 and 2000. By contrast Kiwi Shareholders, by agreeing to the merger gain access to an additional revenue stream of 33.7 cents per kg milksolids for the period 1996 to 2015.
The clear inference in these statements is that these shareholders can expect to receive in the vicinity of 89.83 cents extra for each and every kilogram of milksolids which they supply for the 19 year period up to the year 2015, if the proposed merger went ahead. The ruling price for milksolids was then about 350cents per kg so additional payment as Ernst and Young stated it represents an increase of 25%. This is not too incredible in terms of what can sometimes be achieved in industry rationalisation.
The reality of the situation is 89.83 (and the 141.39) is the sum of the additional cents per kg (present value) which can be expected for each of 20 dairy seasons - an average of 4.5 cents per kg supplied or about 3% extra on average.
This Ernst & Young report was prepared to assist Tui shareholders in deciding how to vote with respect to the proposed merger with Kiwi. The merger was approved by a small margin over the required 75% vote in favour which was needed and the merger went ahead.
Aspects of the validity of the merger including aspects of the Ernst and Young report were challenged in the High Court. The judgement HedleyVKiwi which contains the following paragraph:
[226] Against that evidence given by Ms Taylor and Professor Pratt, Messrs Hagen and Davies said their preferred approach was a forward-looking analysis which concentrated on forward projections and not past performances. Mr Hagen said "fairness" meant assessing whether the 60c differential was appropriate, considering amongst other things the relative expected performance of each company. He emphasised that analysing past results is only relevant if it assists in clarifying likely future performance and outcomes. For that reason he endorsed the pro-merger and EY Jensen analysis of future projected outcomes, including their conclusion that despite a 60c differential the proposal was still fair and in the best interests of Tui shareholders. He said that EY's analysis showed that, without the differential, the Tui shareholders were projected to be approximately 141 c per kilogram of milk ahead of their stand-alone position and even after the differential, approximately 90c ahead.
The Court would here seem to have been mislead into believing that the Tui shareholders would get an extra 90cents per kg of milk supplied on an ongoing basis as a result of the merger. The magnitude of this benefit was a factor in the challenge being rejected.
A complaint on this issue was made to the Institute of Chartered Accountants of New Zealand in 2002. In their response Ernst and Young proclaimed that the sentence "For the Tui shareholder, they access an additional revenue stream of 141.39 cents per kg milkso1ids for the period of 1996 to 2015. " was correct as stated. They accused the complainant of not being familiar with Net Present Value analysis implying that it is alright to express it that way if net present values are involved. But there is no special meaning for the word "per" in that situation. They have used their relative monopoly on knowledge of net present value theory to get away with overstating the additional revenue many fold and so inducing shareholders to vote for the merger because of this inflated expectation.
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